Rethinking the Dominance of the “Loans to Countries”

Model

We identify four areas where the dominant “loans to countries” model could be usefully adapted:

1. A new mandate and approach to global public goods 2. New approaches to sovereign financing

3. Managing growth in private sector finance 4. Sub-sovereign and regional financing Financing Global Public Goods

Recent internal reforms at the World Bank, which aim to reorient the bureaucracy toward new “global practices,” have the appearance of a more robust global public goods (GPG) agenda for the institution. President Jim Yong Kim has pledged that the internal

reorganization will enable the bank to “offer the most up-to-date state-of-the-art global knowledge” in support of its development mission.³⁶

Yet, looking at the reorganization alongside the bank’s recently announced financial reforms, which promise to boost IBRD lending in part through $400 million in administrative budget cuts, it appears that the generation of new knowledge and technologies, among other global public goods, may continue to struggle for attention under a dominant country lending model that remains largely untouched by the bank’s reform agenda.

The case for a strong World Bank role is clear enough (see Box 2) and frequently echoed by many of the bank’s shareholders, but the institution itself continues to operate in a way that has made it ill-suited to the task. In short, countries have very little incentive to borrow from

36 Kim, J. Y., "One Group, Two Goals: Our Future Path." Annual Meetings Plenary. World Bank. Washington, DC. 11 Oct. 2013. Speech.

the World Bank to invest in agriculture or disease research, the outcomes of which are uncertain and the benefits of which are not captured by the country’s government (which has to pay back the loan) or even contained within the country’s borders. In principle, the subsidy provided even under IBRD’s “hard terms” relative the borrowing countries’ own cost of borrowing ought to incentivize some areas of GPG investment, such as employing cleaner energy technologies. But to date, the bank’s borrowers have balked at pursuing this agenda aggressively absent deeper subsidies and additional sources of financing.

Box 2: Why GPGs, and why the World Bank?

Birdsall and Subramanian (2007) make the case for a GPG agenda at the World Bank defined broadly in two areas:

1. “Without collective action to minimize greenhouse gas emissions and develop local systems for mitigating its impact on people, not only will the planet be affected, but the bank’s mission of reducing poverty in the world will be at great risk.”

2. “Around the world, there is a tendency for research and development (R&D) to be under-supplied because it is difficult even for public suppliers (such as the National Institutes of Health in the United States) to capture for their citizens alone all the benefits. But R&D products of interest to poor countries is even more undersupplied…”¹

So, the World Bank could usefully adopt a GPG agenda organized around addressing climate and poverty-oriented R&D agenda. The utility is not in supplanting existing efforts. Certainly on the climate front, that institutional ship has sailed: for a variety of reasons, the climate agenda is being carried forward in multiple institutional settings, including the newly-minted Green Climate Fund.

But just as it makes sense for the World Bank to continue to seek to play a foundational role among a multitude of development finance institutions, when it comes to the official

“development” agenda, the bank could also seek to play this role among the many actors that currently address elements of a global public goods agenda. The World Bank is the leading mobilizer of public resources for development, and as such could bring greater scale to GPG mobilization activities that are currently dispersed across smaller scale efforts.

The bank could also provide a platform to help prioritize among research activities globally and prioritize development-oriented research activities within the broader R&D enterprise.

Finally, the World Bank provides a unique platform for joining the interests of traditional (Western donors) and non-traditional (emerging markets and philanthropic) sources of financing for GPG activities. GPG activities have relied heavily on donor trust funds, some of which have been particularly successful in attracting non-traditional donors like the Chinese government (for example, the Climate Investment Funds). But these initiatives remain isolated and lack a broader platform for engagement across issue areas.

1Birdsall, N. and A. Subramanian, (2007). “From World Bank to World Development Cooperative”, Center for Global Development Essay, Washington, DC: CGD.

The World Bank has sought to innovate within country lending to address GPGs, but these efforts frequently confront limitations of the model. For example, the bank has offered various forms of insurance to countries, most recently to address long term climate risks.

Yet, demand for these products has been limited, with country borrowers reluctant to use

their limited allocations to insure against long term climate risks when shorter term projects with identifiable economic rates of return command greater attention.

The bank has also sought to sustain a public goods-oriented research agenda by relying on overhead and highly dispersed donor-sponsored trust funds. But these efforts have fallen short of enabling the institution to play a large role, let alone a foundational one, in development-related public goods.

In fact, even these limited efforts appear to be in some jeopardy in the face of administrative budget cuts. The cuts themselves, targeted at $400 million over three years, serve to

reinforce the country-lending model since all of the proceeds are intended to boost IBRD capital and promote more lending. While the bank has sought to reassure its shareholders that there is substantial savings to be had through “right-sizing” the institution,³⁷ recent discussions around World Bank grant funding for public goods activities, already very small in scale, may be in further jeopardy.³⁸ Bank funding for the public goods-oriented

Development Grant Facility was cut by 11 percent in FY2014, and in a review of the institution’s grant making facilities, management seemed to signal further diminishment of these efforts.³⁹

In the same report, the bank acknowledges the critical role that investments in new

technologies play in promoting development. In the context of agricultural innovations, the report notes that the bank itself is not a research organization but champions World Bank funding for CGIAR as a way to promote this critical area of work. Yet, the institution’s contributions to CGIAR have been flat at a modest $50 million a year, and there is very little else in the bank’s funding activities that suggest a prioritization of an R&D agenda.

What would it take for the World Bank to realize a robust global public goods agenda, particularly in the areas of climate and R&D? We see three critical elements: a clear mandate from shareholders; a dedicated funding stream appropriate to public goods activities; and flexibility in design.

1. A clear mandate for GPGs.

By some measures, there seems to be ample shareholder will to address GPGs, evident in many rounds of Development Committee statements that have addressed the climate agenda. Yet, this sentiment has not been harnessed adequately to establish an autonomous agenda within the institution. For too many years, the messages from the bank’s owners (borrowing and non-borrowing countries alike) have been mixed when it comes to elements of a GPG agenda, generally foundering on the tension between country ownership of the

37 Shahine, A, and Sandrine R. "Kim Sees Job Cuts at World Bank in Effort to Lower Spending." Bloomberg Business, October 10, 2013.

38 Birdsall, N. (2014). “My Two Big Worries About the World Bank,” Blog post, Center for Global Development.

39 World Bank (2013). “A Consolidated Report on the World Bank’s Grant Making Facilities for FY14”, Global Partnerships and Trust Fund Operations. Washington, DC: World Bank.

bank’s lending relationships and the need a global institution to set global priorities, even when they may not be priorities for individual countries. The bank’s climate agenda has been rife with disputes over whether money for climate mitigation and other public goods will be additional to the bank’s core financing for borrowing countries or shoehorned into the existing country financing relationships.

The World Bank itself has to do a better job of proposing a coherent GPG mandate in a manner that does not send the shareholders to their entrenched battle lines. It need not be as hard as it sounds. For example, rather than a conversation about how much bank lending should be carved out from borrower’s own priorities in order to address climate, the bank can start a discussion about an R&D agenda that promotes a global good while meeting countries’ development needs. China, for example, has a lot at stake economically in moving carbon capture and sequestration (CCS) forward.⁴⁰ And if CCS were to operate at scale, climate as a GPG would clearly benefit. Yet, the bank itself has been largely absent from the development of technologies and innovations like CCS.

Of course, not all of a GPG agenda falls so neatly into the category of a win-win

technological innovation. But introducing the possibilities of a new, flexible grant instrument at the bank that meets a dual mandate of GPGs and country-driven development could go a long way toward bringing all of the bank’s shareholders on board.

2. A dedicated grants-based funding stream, tied directly to the mandate.

By definition, public goods activities do not lend themselves to financing by the marketplace or on market terms, and even concessional lending has not proved attractive in incentivizing investments in GPG activities. Instead, what is needed is a dedicated, and the bank’s client countries would say an “additional,” grants-based funding stream.

To date, the World Bank’s grant support for many areas of GPGs has relied on trust funds and small line items in the administrative budget, none of which has added up to a robust financing stream. The World Bank does have a long-standing and highly successful grants-based model for assistance in form IDA. But the model is country grants-based and the grant element is determined purely as a measure of country need. Nonetheless, IDA is relevant because heavy reliance on grants in IDA programming has also driven a robust fundraising mechanism that has secured over $250 billion in grant contributions from donors since its founding in 1960.

The IDA experience demonstrates the importance of having a distinct grant-making entity within the institution supported by a clear mission. The World Bank is, after all, a bank. As such, incentives arise around lending and private investment, with appealingly quantifiable measures of success in the form of dollars lent and in the case of the IFC, direct returns on investment. Grant activities can struggle for air in this environment. The success of IDA has

been to ring-fence an area of bank activities and create strong political support for them. In this sense, while IBRD success has been measured by volume of lending, IDA success might be measured by dollars raised from donors. Both may be suspect, but they are instructive for the GPG agenda.

In terms of a new financing stream, there are a number of promising building blocks:

 Donor contributions. Looking to existing IDA replenishments would provide the first of the building blocks. Expanding the scope of IDA replenishments to a broader “Bank Resource Review” model⁴¹ (as we discuss in Section 3) would enable some donor grant contributions to migrate away from IDA in future years in response to IDA country graduations. Near-term IDA graduations imply a decline of about $3 billion a year in demand for IDA resources. Even if half of this amount was retained as additional support for the remaining IDA countries, $1.5 billion of donor grants could be channeled toward a new GPG grant facility annually.

 IBRD/IFC net income. Similarly, existing World Bank commitments to dedicate a share of IBRD and IFC net income to IDA provides a basis for other uses of bank income. As an indicative measure, the IBRD and IFC have made combined annual income transfers to IDA averaging just over $1 billion during 2011-2013.⁴² While there is certainly variability in income, particularly IFC earnings, it is questionable that IDA will continue to claim such a high priority on bank income going forward.

Decisions about directing some share of annual earnings to a GPG facility would be part of the broader discussion about how to allocate earnings, looking at bank capital needs, administrative budget, and IDA needs.

 Emerging market donors. China has come along grudgingly as a donor at the World Bank, but nonetheless has significantly increased its grant-based support for IDA. Emerging market countries generally have been increasing their IDA

contributions. Imagine, then, how much more motivated they might be as donors to a facility that, unlike IDA, they helped to create and from which they stand to benefit? Further, with a clearly defined R&D mandate, the new facility might be able to draw on sources of funding from these countries outside of their very limited foreign aid budgets.

 New donors. In establishing a new core financing facility, World Bank shareholders should consider an approach already employed in some of the bank’s trust funds:

accept funding from non-sovereign donors. Philanthropic actors like the Bill and Melinda Gates Foundation have been increasingly active, sometimes even dominant, donors to World Bank trust funds like GAFSP or financial intermediary funds like the Global Fund. As an indicative measure, the US-based “Giving Pledge” has attracted pledges that have recently topped the $1 trillion mark. Given the grant

41 Morris, S. (2014) “Shaking up the Donor Shakedown at the World Bank”. Center for Global Development Essay. Washington, DC: CGD.

42 See IBRD and IFC financial statements.

making focus of the family foundations and individuals behind this pledge, as well as their interest in environmental, agricultural, and health-related public goods, the World Bank’s sovereign shareholders would do well to invite these private actors into the bank’s GPG-related grant making.

 Revisiting the 2014 financial reforms. The 2014 financial reforms were remarkable for enabling the IBRD to nearly double its lending capacity without seeking new capital from bank shareholders. One of the risks of these measures, which rely in part on higher loan charges and administrative budget cuts, is that they will prove unnecessary due to declining demand for IBRD loans. The bank is staking a lot on massive infrastructure investment needs globally, which is certainly compelling from a development perspective.

Of course, the potential problem of too little demand is largely self-correcting, except for the administrative budget cuts. Rather than proceed with $400 million in budget savings going directly into IBRD retained earnings, some or all of these savings should be on the table for consideration in the new GPG facility. After all, the conversation itself is fundamentally about where the bank’s shareholders see the greatest value for the use of their funds. And if the bank’s borrowers in particular are signaling less interest in borrowing at the level of $28 billion a year, they might in the alternative prefer to see some of that capital deployed to a GPG like agricultural R&D.

3. Enough flexibility in design to avoid capture within the existing silos.

There is a temptation, particularly among IDA donors, to seek a GPG mandate within IDA.

In part, this recognizes the need for grant financing. But it also reflects the relative influence of these donors within IDA compared to their influence outside of IDA. IDA is the

preferred instrument for GPGs because it is the instrument over which GPG advocates have the most control. This approach is limiting on the GPG agenda and unfair to IDA countries since it sets up a direct tradeoff in the use of IDA resources and in turn limits the use of those resources to IDA countries alone.

Flexibility should also come with questions about eligible funding targets. Certainly, when it comes to funding R&D, the bank should be willing to fund institutions and projects that can best support the mission, whether they are in Mumbai or Menlo Park. This should not be a particularly controversial view, yet the long dominant mindset that World Bank resources are only channeled to developing countries stands in the way of using these resources more effectively for development.

New Instruments and Approaches for Sovereign Engagement A mandate and financing stream for global public goods would mark a clear departure away from the loans to countries model for the World Bank. Yet, there is also considerable room for innovation within the traditional area of sovereign engagement. We consider here four areas of innovation with regard to how the World Bank lends to countries, starting with the bank’s role in country-level crisis response, and the related potential for greater efforts around sovereign risk management. We then look at future prospects for the bank’s most innovative effort in years around sovereign lending, the Program for Results instrument.

Finally, we consider the potential for major changes to IDA’s long-standing performance-based allocation mechanism.

Crisis Response

The recent Ebola crisis in three IDA countries has highlighted the question of what role the World Bank more generally has to play in crisis response at the country level. Whether due to a pandemic or an economic shock of a different nature, it is clear that the bank can play a useful role in countering the negative economic impacts of such shocks, either by mobilizing resources quickly after a crisis hits or by insuring against crises on an ex ante basis. IDA’s Crisis Response Window (CRW) is an effort to do the former, and the World Bank’s recent proposal for a “Pandemic Emergency Facility” aims to do the latter.⁴³

In general, an insurance model, whether in the traditional sense or in forms like catastrophe bonds is desirable in minimizing the opportunity costs evident in scarce grant funds sitting idly in a set aside like the CRW. But there is considerable uncertainty about the functioning of insurance and bond markets around new event triggers like pandemics.⁴⁴ And pricing in the face of uncertain determinations of risk may be such that considerably grant resources would still need to be deployed on an ex ante basis (for example, to subsidize premiums paid by country governments).

It will be important to avoid viewing crisis response through the lens of the last crisis. As devastating as Ebola has been in human and economic terms, and however ominous the prospects for future pandemics, this may be an overly narrow lens through which to consider a broader, rationalized World Bank approach to crisis response, recognizing the bank’s role is fundamentally an economic one, providing a counter-cyclical financing response to economic shock.⁴⁵ From this perspective, it matters less that the impetus is a

43 Kim, J. Y. "Lessons from Ebola: Toward a Post-2015 Strategy for Pandemic Response." Presentation, Georgetown University, January 27, 2015.

44 Talbot, T. and O. Barder (2015). “The Can and Can’t Do of Cat Bonds,” Blog post, Center for Global Development.

45 Of course, the World Bank also has an important role to play in crisis prevention, whether it is to promote

45 Of course, the World Bank also has an important role to play in crisis prevention, whether it is to promote

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